Contractors Warn of Bad Surety Bonds

By Bill Dries

A rash of bad construction project surety bonds in three states and American Samoa landed at Memphis International Airport this summer with plans to demolish the Regency Hotel on the grounds of the airport.

Road construction projects such as the current one at Interstate 240 and Walnut Grove Road are the types of public projects that have governments taking pause.

(Daily News/Andrew J. Breig)

In September, the Memphis-Shelby County Airport Authority announced it would rebid demolition of the airport hotel because of problems with the surety bond of the previous low bidder, Nelson Inc.

The problem with the $485,000 bid that caused it to be tossed involved surety bonds bearing the name of Chubb Insurance. It has prompted the head of the West Tennessee branch of Associated General Contractors of Tennessee to call on the government agencies overseeing the projects to be more vigilant.

The surety bond is submitted when a company bids on a publicly funded or finance project.

The backing of the bond company insures that if the contractor gets the contract and defaults or goes out of business that the bond company will find another contractor to finish the project.

“It’s not an insurance policy. But what it does is the surety company will then come forward and they will complete the project,” said Terry Lotz, executive director of the West Tennessee Associated General Contractors branch. “There’s a lot of different ways they can go about it. It takes the additional financial burden off the public entity that is the owner of the project.”

That happens at no cost to the public entity and the contractor in default forfeits up to 5 percent of the bond cost.

“There’s an involved process here,” he said of the claims process when a public entity contacts the insurer. “They are going to look at it. They are going to talk to the contractor. They’ll figure out what’s going on. … They will find a new contractor to take over the job, finish the job.”

Then the contractor in default and the insurer work out how the insurer will get its money without involving the government entity.

Chubb is among several hundred insurers who offer surety bonds that are on a U.S. Treasury list that by Tennessee law is the required list issuers of surety bonds must be on for public projects in the state.

The contractors association was instrumental in getting the state law changed recently to move away from individual sureties.

“There had been reports over the last many years where they went back against the individual sureties and the assets that supposedly were there underwriting these individual sureties – they weren’t there,” Lotz said. “They really weren’t in business with that distinct purpose in the first place.”

The Treasury list also makes it easier for architects and engineering firms who often set the specifications for bids to check the legitimacy of surety bonds before the bids are ever opened and a contract awarded.

“The way that you stop that is I look at the bond and they are on the list. I only have to take one more step,” Lotz said. “Based on the national headquarters number, I pick up the phone. There’s a bond number on every bond. I call their bonding office. I give them that number and I only say, ‘Is this a good pay performance bond number?’”

Within the phone call, Lotz said the insurer should be able to verify the number of say it is not legitimate.

“Our public officials aren’t doing that,” he said. “I don’t even know that they know to do that. That is what we want to get accomplished is to get everybody on the same page, so that they understand what is involved and the process they can take. It’s minimal at best.”

Lotz is also working on setting up meeting with local engineering and architecture associations to raise awareness.

The problems in the other states involve fraudulent Chubb bonds that small contractors are paying premiums on and losing the premiums on as Chubb discovers the fraud and tells the contractors they are not authorized.

One of the cases was a $5.5 million Navy museum and visitors center in St. Mary’s County, Md.

That case and others outside Memphis are being investigated by the FBI, according to Engineering News-Record, a trade publication that is where Lotz learned of the problem.